Lord et al Managing risk and value in mineral exploration

MANAGING RISK AND VALUE IN MINERAL

EXPLORATION
Deborah Lord, Michael Etheridge and Phillip Uttley,
SRK Consulting
Abstract
Exploration is a high-risk business often involving the expenditure of
large sums of money for seemingly little return. To be commercially viable
exploration needs to compete with alternate strategies available to
companies for acquiring mineral commodities. In the past decade
discovery rates have fallen, despite record international exploration
expenditures. This has lead to a loss of investor confidence in the
exploration industry. However, the reward to risk ratio is high for
successful explorers. Successful mineral exploration requires a clear
strategy and well-defined exploration models for the deposit styles being
sought. In order to meet corporate/management objectives this
exploration model needs to be matched with the companys business
objectives via an economic/financial framework. Given that exploration
lead times are also often quite extended, we need to be able to critically
examine and manage the risks associated with exploration and the
likelihood of return on the investment in exploration. This paper will
describe a method to evaluate risk in exploration, progress to discovery
and the probability that a resource will be discovered and will be
economically viable. In order to examine risk, exploration is divided into
several key exploration stages. Each project area can be evaluated in
terms of the likelihood or probability of progression to the next
exploration stage. To provide the link to the potential economic return on
exploration, a target value for the deposit style being sought is required.
Using a simple spreadsheet analysis, the distribution of risk by
exploration stage can be examined. The maximum value creation and
highest risk in exploration occur at the more advanced exploration stages,
particularly after the first mineralised hole is drilled. Selected case
studies will be included to demonstrate the practical application of the
method outlined. The paper will outline the main risks involved in the
exploration process, and summarise the critical success factors that can
assist companies to lessen the risks associated with exploration.

Introduction
SRK has been developing a method to evaluate risk in exploration, progress to
discovery and the probability that a resource will be discovered and will be
economically viable (Lord et al., 2001). It is a probabilistic approach based on modern

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 Lord et al Managing risk and value in mineral exploration

decision theory, and is commonly applied in a wide range of commercial and

scientific environments. In particular, the petroleum industry uses a similar approach
to examine risk in exploration (e.g. Harbaugh et al., 1995).

Other workers have proposed a risk based approach to exploration management and
their work is recognised in the development of our methodology (e.g. Mackenzie,
1998; Singer and Kouda, 1999; DeGeoffroy and Wignall, 1985).

Progress in exploration
The exploration process comprises a sequential series of go or no-go decisions
being made at each of the key exploration stages. A decision to proceed would mean
that the reward is expected to outweigh the risks involved (i.e. positive expected
value and the investment is made). A decision to terminate would mean that the risks
and costs are expected to outweigh the reward (i.e. negative expected value and the
project is relinquished or joint ventured).

In order to examine risk, exploration is divided into several principal exploration

stages, from project generation through to feasibility, as shown in Table 1 and Figure
1, and outlined below:

Stage A. Project generation / ground acquisition;

Stage B. Prospect definition / reconnaissance exploration;
Stage C. Drill testing;
Stage D. Resource delineation / detailed drill testing;
Stage E. Feasibility study.

The critical value-creating step is between Stages B and C that results from the
drilling of an economic intersection (or one that indicates the prospect has
significant economic potential). In Stages C or D, the critical factors are size
potential, higher grades and continuity of mineralisation.

Thus the early Stages A and B can be described as geological and Stages C and D as
economic. This emphasises two important definitions of exploration economics:

The technical success of the mineral occurrence in Stage C (being defined as

indications of potentially economic mineralisation across potentially economic
mineable widths), and
The economic mineral deposit determined by feasibility study in Stage E.

The two are often confused, resulting in the term technical success of an exploration
program. An important aspect of exploration is the low probability of an economic
mineral deposit, even given technical discovery of a mineral occurrence.

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 Lord et al Managing risk and value in mineral exploration

Exploration Stages As Valuing Minerals Exploration By Project

Defined For Valuation: - Exploration Milestones
A. Ground Acquisition Goals To build an expert team for the belt/region
To have knowledge, knowledge management and
data/information availability for the belt
To acquire ground in well endowed belts,
considering availability, political/environmental risks
Probabilities/risks associated with progressing from Stage A to Stage B, i.e. p (A-B)
Probability that the process of Ground Acquisition (A) will result in the acquisition of high
quality, well endowed and available ground that is worthy of further work
B. Prospect Definition Goals To define drillable targets
(Mapping & Geochem) To build area knowledge, quality data management
systems, suitable geological models
To use efficient exploration methods, geologic skills
of exploration team
To define prospect risks and target ranking tools,
exploration audit process
To test presence of mineralizing system
Probabilities/risks associated with progressing from Stage B to Stage C, i.e. p (B-C)
Probability that this process will define drillable targets, (features that meet criteria of the
geological model and knowledge of the area)
C. Drill Testing Goals To test geological models, accuracy of mapping and
(Systematic RC, DD) sampling
To test geological information gathered during
prospect definition
To test and prove the presence of mineralizing
system
To drill an economic drill intersection
Probabilities/risks associated with progressing from Stage C to Stage D, i.e. p (C-D)
Probability that the drill testing phase will result in one or more "economic drill intersections"
that would be further drill tested The decision to continue would be supported by other
geological information that would give some initial confidence in the continuity of
mineralisation
D. Resource Delineation Goals To have confidence in size and grade potential,
continuity of grade and geological setting
To understand controls on grade distribution (low
cost curve position)
Probabilities/risks associated with progressing from Stage D to Stage E, i.e. p (D-E)
Probability that a "drill-out" will result in the definition of a preliminary resource that is
sufficiently robust at present prices to warrant proceeding to feasibility
E. Feasibility Goals To determine metallurgy, metal prices, mineability,
cost, prices, mineral balance sheet
Probabilities/risks associated with progressing from Stage E to Stage F, i.e. p (E-F)
Probability that the feasibility study will deliver an ore reserve
F. "Bankable" Reserve
NPV of the "Bankable" Ore Reserve (Based on expected DCF of target deposit style
size, grade, metallurgy, mining costs, metal prices and country location etc.)
Table 1. Summary of principal exploration stages. These stages
generally equate with most Company reporting practices.

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 Lord et al Managing risk and value in mineral exploration

E x p lo r a tio n P r o c e s s - D e liv e r y o f R e s o u r c e a n d V a lu e t o M in in g D iv is io n

E x p lo r a t io n S ta g e s
G e o lo g ic a l In v e s t ig a t io n S ta g e s E c o n o m ic E v a lu a tio n S ta g e s

A B C D E $
R is k R is k R is k R is k R is k
P r o je c t G e n e r a t io n / R e c o n n a is s a n c e / D e ta ile d R e s o u r c e F e a s ib ilit y E x p e c te d
G r o u n d A c q u is it io n T a r g e t D e fin itio n D r ill T e s t in g D e lin e a tio n S t u d ie s
V a lu e to b e
P A P B P C P D P E d e liv e r e d to
M in in g
C A = $ C B = $ C C = $ C D = $ C E = $ D iv is io n
E x p e c te d
E V A = $ E V B = $ E V C = $ E V D = $ E V E = $ N P V o f ta r g e t
d e p o s it s ty le

T e c h n ic a l S u c c e s s =
D e c is io n to D r ill T e s t E c o n o m ic D r ill In te r s e c tio n E c o n o m ic S u c c e s s

R is k a n d D e c is io n P o in ts in E x p lo r a tio n P r o c e s s fo r o p tio n s to p r o c e e d o r a c q u ir e ,
( a t h ig h e r c o s t a n d lo w e r r is k ) , o r to te r m in a te o r s e ll.

E V = P .T V - C E V = E x p e c t e d V a lu e o f d is c o v e r y a t S ta g e
P = P r o b a b ilit y o f s u c c e s s
C = C o s t o f e a c h S ta g e
T V = T a r g e t V a lu e = N P V o f c o n c e p t u a l d e p o s it s t y le

Figure 1. Flow chart showing principal stages in the exploration process and associated risks

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 Lord et al Managing risk and value in mineral exploration

Expected value of discovery

To provide the link to the potential economic return on exploration, a target value for
the deposit style being sought is required. The measure most commonly used to
provide the target value is the Net Present Value (NPV) of the target resource. This
will vary, depending upon the individual companys targets or minimum acceptable
thresholds.

In our approach, the Expected Value of an exploration prospect (at any particular
exploration stage) is defined as the probability of the exploration prospect advancing
to the next stage times the target value, less the cost of advancing to the next stage.
This can be expressed as:

EV = Ps. TV - C
(Where EV = Expected value, Ps = Probability of success /
advancing exploration prospect, TV = Target value and C = cost of
exploration for that stage).

This simple formula generates an expected value for each prospect at each of the main
exploration stages, by working back from the companys exploration target value or
minimum acceptable threshold.
Assessing early stage exploration projects
The probability of success for the early stages of exploration (Stages A, B and C) are
based on elements of the geological mineralisation model present at the individual
prospect area. Elements of the mineralisation model are defined as critical success
factors or geological factors that must be present to ensure formation of the mineral
deposit. The approach requires:

Building the underlying process model

Identifying the critical success factors, and
Assignment of the probability of occurrence to each factor.

The probability of the occurrence of a mineral deposit can be derived from the
product of the relative probabilities of each of the critical success factors (Bayesian
probability). With increasing expenditure and knowledge, the probability of
occurrence provides a rigorous measurement of exploration progress and a robust
means to rank projects at different stages:

PS = P1.P2.P3.P4

(Where PS = relative probability of success/occurrence of the

mineral deposit, P1-4 = probability of occurrence of each of the
critical success factors of the geological model).
In our experience, usually no more than 3 or 4 critical success factors will apply,
based on the fundamental processes of the geological model, as follows:

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 Lord et al Managing risk and value in mineral exploration

1. Source of mineralising fluids (P1)

2. Active geological structures to provide a pathway (P2)
3. Evidence for movement of those fluids (P3), and
4. A structural or reactive trap to cause deposition of metals from mineralising
fluids (P4).

For each relative probability of the critical success factors described above, a value
between 1.0 and 0.0 is assigned, where a value of 1.0 indicates that the factor is
definitely present. A value of 0.5 is assigned where information about the factor is not
known or data is not available. Therefore a relative probability >0.5 indicates that
there is a degree of evidence that the factor is present, whereas a relative probability
<0.5 indicates that there is a degree of evidence that the factor is not present.

Each project is carefully reviewed in relation to the geological process model for the
target or region. Relative probabilities are assigned to each factor for each project, and
multiplied to obtain a Probability of Success (PS) that all of the essential
components of the mineralising system are present in the target or region, see Table 2.
This probability is then assigned to the relevant Exploration Stage on a spreadsheet,
representing the probability that the prospect could advance to the next phase of
exploration.

Probability of Exploration
Relative Probabilities
Success Stage
Project P1 P2 P3 P4 Ps
Alpha 1.0 0.8 0.9 0.8 0.576 D
Bravo 0.9 0.9 0.7 0.8 0.454 C
Charlie 0.9 0.8 0.7 0.5 0.252 B
Delta 0.5 0.8 0.8 0.9 0.288 B
Echo 0.8 0.9 0.6 0.7 0.302 B
Foxtrot 0.9 0.8 0.8 0.8 0.461 B
Golf 0.7 0.9 0.6 0.6 0.227 B
Hotel 0.7 0.6 0.6 0.5 0.126 B
India 0.5 0.5 0.6 0.5 0.075 A
Table 2. Example of Bayesian probability analysis for regional
exploration prospects.

Ranking targets
Comparing the number for the probability of success enables the prospectivity,
ranking and the exploration progress on a project to be monitored and reported
following each phase of work and budget, as the relative probabilities of the critical
success factors either increase or decrease with added knowledge. A simple
spreadsheet can be constructed showing the probabilities assigned to each project and
rankings by the relative probabilities of success. Projects with the highest
probabilities of success may be targeted as priority, and those below an agreed
threshold probability may be divested. A plot of risked value against cumulative
exploration expenditure is a measure of exploration progress and a key indicator of
decision points.

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 Lord et al Managing risk and value in mineral exploration

The main applicability of the Bayesian-type probabilistic approach is in the target

definition stages of the exploration process, i.e. in the 'Reconnaissance' and Drilling
Stages'. It provides a means of ranking projects at these stages and focussing the
program on the most prospective targets (Figure 2).

The benefits of a probability approach for measuring prospectivity, ranking and

progress include:

Simple to apply, semi-quantitative and mathematically sound

Consistent, disciplined approach to ranking reviewing targets/prospects/and
belts
Challengeable and changeable, and can be presented and updated in a template
spreadsheet for all key parties to critically review and have input.
Identifies critical success factors and key information gaps
Basis for definition and tailoring of work programs
Provides readily available measures of exploration progress and rank, related
to the increasing expenditures
When the probability of discovery, or the value falls below an agreed
threshold then it is time to move on.

The approach also provides project geologists, exploration managers and

corporate/board level managers non-technical tools to communicate and understand
the progress of each exploration project. It uses a number of simple graphical tools
that can be developed to:

Chart the progress of the project towards discovery or termination

Measure the effectiveness of the project in terms of the geological model that
underpinned tenement acquisition
Assess risk in a consistent and quantitative fashion, and measure planned
expenditure against the risked value of the project
Define the critical information and knowledge gaps that provide the maximum
risk reduction and progress towards discovery.

Determining late stage probabilities

As most exploration projects will tend to fall into the early Stages B & C, it is
necessary to assign probabilities to the later Stages from C to D to E in order to
complete a valuation spreadsheet. This requires estimation of regional, or belt-wide
probabilities for the style of target sought by the Company, which would appear to be
more difficult than the early stages readily provided by Bayesian analysis.

A range of probabilities can be estimated at each of the later Exploration Stages based
on the high knowledge and experience in each belt, e.g. number of prospects
generated, the number that advanced to drilling and to resource definition and finally
to feasibility studies. Where a Company has a long history of exploration on large
tenement blocks in belts, a range of probabilities can be readily established.

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Figure 2. Graph showing example of relative prospect ranking

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 Lord et al Managing risk and value in mineral exploration

For example, SRK recently undertook a review of a 13-year exploration program at

Laverton in conjunction with Placer (Granny Smith) Pty Ltd (see Lord et al., 2001). In
this period Placer (Granny Smith) spent AUD$52 million on exploration, defining 12
deposits with combined resources of more than 10 Moz (310 tonnes) of gold.
Exploration in the district covered 21 project areas and each of these were reviewed
with the geological team to examine key exploration decision points, expenditures per
exploration stage, number of prospects and targets generated in each project area, etc.

Using this detailed study, data was compiled on probabilities of exploration success
through each of the defined stages and the associated costs of advancing exploration
prospects from project generation to mining (Table 3, Figure 3). While the
quantitative results are specific to the Laverton District, the methodology can be
applied to near-mine, advanced and grassroots exploration programs for any deposit
style and in any geological environment. Our analysis also demonstrated that while
the overall program was highly successful, even greater value could have been
delivered.

Exploration Number Expenditure Average cost Probability

Stage of 1987 - 1999 per prospect of advancing
prospects
Generative 290 $2.7M $10K
Reconnaissance 156 $11.4M $70K 0.54
Systematic drill 26 $6.0M $230K 0.17
testing
Resource 15 $6.9M $460K 0.58
delineation
Feasibility study 13 $27.6M $2.1M 0.87
Mine 12 0.90
Table 3. Synthesis of historic exploration activity by exploration
stage at Laverton by Placer (Granny Smith) (from Lord et a,, 2001).

Where this knowledge is less known (for example in new grassroots geological
environments), these belt-wide probabilities have to be assumed by the geologist
based on their high knowledge of the belt, available historical data and collective
experience. Assigning belt wide probabilities may seem difficult at first, but in reality
this is what the exploration group does every time it makes a decision to acquire a
property, or to spend Company funds on a prospect to progress it to the next stage.

Risk profiles in exploration

Using a simple spreadsheet analysis, the distribution of risk by exploration stage can
be examined (Figure 4). A typical risk profile for exploration demonstrates that the
highest risk (and importantly also the maximum value creation) in exploration occurs
at the more advanced exploration stages, particularly after the first mineralised hole is

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 Lord et al Managing risk and value in mineral exploration

Figure 3. Graph of probability of success by exploration stage at

Laverton.

Figure 4. Graph of risk profile by exploration stage at Laverton.

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 Lord et al Managing risk and value in mineral exploration

drilled. The highest risk phase is from Stage C to Stage D (i.e. to proceed through
Stage C and progress to Stage D).

This demonstrates the problem of generating too many projects at an early exploration
stage. The increased risk and cost of such an approach comes from having to move
low or negative value projects, along with those of high vale, through the early stages.
This is precisely how exploration can destroy value.

Selection of high quality, or well endowed ground along with turnover of

exploration projects are two of the key critical success factors required to sharpen the
exploration focus. Knowledge management, therefore, is one of the best risk reduction
techniques available to the exploration group. If corporate knowledge, and
accompanying effort and budget are spread too thin across many regions / province /
projects and offices, then this will lead to increased risk in Stages A, B and C.

Other applications of this approach

SRK initially developed this methodology to assist in ranking exploration targets,
evaluate risk in exploration and examine exploration progress. However, there is also
wide ranging application to other facets of exploration management including due
diligence studies, audits and independent project valuations. Increasingly it is also
being applied to support exploration decision - making and to identify and examine
geological risk factors.

A project recently completed with Bendigo Mining NL provides an example of

examining geological risk factors within a conceptual mining study as a basis for
internal valuation for capital raising (SRK, 2001).

SRK worked closely with Bendigos team of mining consultants whose role was to
build the conceptual mining and processing plan for the New Bendigo project. This
conceptual plan formed the basis for discounted cash flow financial models to
calculate Net Present Values (NPVs). SRK examined the geological risk that the
conceptual mine plan would not be achieved, and subsequently analysed the impact of
this upon the projects financial models and NPV values.

The key assumption made in the conceptual mining plan was that New Bendigo will
deliver similar tonnes and grade per unit strike-kilometre of unmined ribbon, and in
similarly shaped and distributed bodies to those historically mined. On that basis and
after detailed examination of previous mining records etc, an estimation of the total
potentially mineable gold endowment of some 12.3Moz of gold was made.

The project SRK completed assessed all of the inputs into the historic reconstruction
and the conceptual mining study. Three principal geological risk factors were
identified and quantified using probabilistic methods. In addition, risk ranges were
assigned to each geological risk factor and a basic sensitivity analysis was carried out
using Monte Carlo simulation. Using this, an overall geological risk-discount was
applied to the NPV values generated for the New Bendigo gold project.

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 Lord et al Managing risk and value in mineral exploration

Critical success factors to minimise risk in exploration

Based on our experience in a number of company reviews and independent technical
assessments, the key questions often asked by senior management when deciding to
risk part of Company profits on exploration, and by investors when considering an
investment in a mining exploration company, relate to the principal risks:

What is the value of the target to the Company, and will it provide an adequate
return to shareholders in view of the high risk?
Is the Company focused in the most prospective areas for the commodities
sought?
What is the probability that a resource will be successfully discovered and will
be economically viable?
Where does the project sit on the pathway to discovery?
What will be the cost of the project, to at least feasibility stage, in view of the
Companys limited funds?
What is the likelihood that the Companys exploration division has the
necessary knowledge and skills required for discovery?

As geologists we need to be able to provide information that helps to answer these

questions.

After undertaking a number of Company reviews, and examining various published

case histories of successful exploration (worldwide) over the past 20 years or so, we
have analysed what makes for successful exploration. The critical success factors that,
in our opinion, had potential to substantially lessen the high risk of exploration, are as
follows:

Acquisition of high quality ground by expert teams assembled for the task
Focused exploration on a small number of well-endowed mineral belts
Detailed knowledge of both the belt and explicit geological models
Application of effective exploration technology and tactics
Willingness to drill early and use drilling as a geological tool, thereby
spending a significant proportion of budget on drilling
Geological ability to expertly recognise significant drilling intersections /
mineral occurrences
Corporate and financial commitment from Board level down, based on well-
founded persistence
Willingness to accept a higher than normally acceptable level of country risk
at early exploration stages
In merger and acquisition strategies, the ability to recognise and value hidden
exploration potential and synergies.

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References
DeGeoffroy J. G., and Wignall T. K., 1985. Designing optimal strategies for mineral
exploration: Plenum Press, New York.
Harbaugh J. W., Davis J. C., and Wendenbourg J., 1995. Computing risk for oil
prospects principles and programs: Pergammon, Briddles Ltd, Great
Britain.
Lord D., Etheridge M., Willson M., Hall G., and Uttley P., 2001. Measuring
exploration success an alternative to the discovery-cost-per-ounce method
of quantifying exploration effectiveness: Society of Economic Geologists
Newsletter, No 45.
Mackenzie B. W, 1998. Economic evaluation for mineral investment decisions: Short
course notes, 2 volumes, Australian Mineral Foundation, Glenside, South
Australia, (unpublished).
Singer D. A. and Kouda R., 1999. Examining risk in mineral exploration: Natural
Resources Research, v. 8, p. 111122.
SRK, 2001. Assessment and quantification of geological risk pertaining to the New
Bendigo conceptual mining study and its relation to project value: Internal
report to Bendigo Mining NL, (unpublished), [posted on Bendigo Mining NL
website, //www.bmnl.com.au.]

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